Congress, to its own chagrin, has yet to resolve the fate of Fannie and Freddie more than a decade after they were taken into federal conservatorship. The last major bipartisan push at GSE reform fizzled in 2014, but neither Congress nor the administration is fond of the status quo. The pre-crisis GSE model of priva- tized upside gains with catastrophic losses borne by taxpayers remains widely maligned a decade after catastrophic losses erupted. A new bipartisan GSE re- form bill was introduced in the House Financial Services Committee in Septem-
ber 2018. While the GSEs’ retained portfolios have been shrunk significantly, their MBS guarantee books have been allowed to grow without limit, and they remain behemoths of U.S. mortgage finance; the GSEs own or guarantee over 42% of U.S. residential mortgage debt.56 Some form of government-sponsored secondary market will surely persist so long as Congress remains wedded to 30- year fixed-rate mortgages with a prepayment option. It is beyond the scope of this paper to weigh the wisdom of that entrenched preference, but it will surely shape reforms to the GSE model and U.S. housing credit policies.57
One leading contender on Capital Hill is replacing the GSEs with a system of bank-issued MBS explicitly guaranteed by the Treasury, but with private capital absorbing the first 10% of losses.58 The proposal would reinstate a version of
privatized gains with risks backstopped by the Treasury. The other leading con- tender in Congress is replacing the GSEs with an expanded role for government- owned Ginnie Mae: Ginnie would additionally guarantee pools of privately insured conventional mortgages in exchange for fees, with the Treasury absorb- ing net earnings and backstopping credit risk.59 Conversely, Congress could
rescind conservatorship and recharter the GSEs as private entities notionally severed from an implicit government guarantee, as the administration recently proposed (OMB, 2018). If legislative reforms continue to stall, administrative reforms might instead be used to shrink the GSEs’ market footprint by reducing the conforming loan limit, tightening underwriting standards, and raising MBS
56Looking at flows, roughly 70% of mortgages originated in 2017 were backed by Fannie,
Freddie, or Ginnie (OMB, 2018).
57For instance, in outlining priorities for housing credit policy reform in 2013, President
Barack Obama emphasized that any legislation “should preserve access to safe and simple mortgage
products like the 30-year, fixed-rate mortgage” (Obama, 2013).
58Such a proposal drafted by Senator Mark Crapo and Senator Tim Johnson passed the Senate
Banking Committee in 2014.
59A bipartisan bill sponsored by Representative Jeb Hensarling and Representative John De-
laney proposed such a model in September 2018, and Senator Bob Corker and Senator Mark Warner recently proposed a similar Ginnie model of GSE reform.
guarantee fees (Parrott and Zandi, 2018).
While Congress has fixated on market structure and downside losses, the elephant in the room remains the extent to which mortgage debt will be sub- sidized in the next iteration of secondary markets. GSE reform might curtail the subsidization of mortgages via implicitly guaranteed agency bonds only to increase subsidization by underpricing risk on explicitly guaranteed MBS. Dy- namic responses to GSE purchase shocks suggest that housing policy objectives can be advanced through a subsidy channel, while the subsidized expansion of mortgage lending unintentionally crowds out commercial lending through credit supply and bank lending channels. Underpriced guarantees can likely advance Congress’s various housing policy objectives through a subsidy chan- nel, but may induce a varying degree of credit crowd out. Guarantees leave in- terest rate risk borne by the private sector, potentially driving a smaller wedge in marginal origination incentives and weakening the mortgage origination channel of housing credit policies. Prepayment risk may render agency MBS a weaker substitute to bank debt than noncallable agency bonds, altering portfo- lio rebalancing effects through the safe asset supply channel. A complementary empirical analysis of the macroeconomic effects of government mortgage guar- antees is left for future research. Regardless, policymakers should weigh the op- portunity costs of subsidizing mortgage debt, notably fiscal costs to taxpayers, horizontal inequities between homeowners and renters, and crowd-out of non- targeted lending and real activity; overhauling budget scorekeeping rules that understate the net present value of credit subsidies would help (Lucas, 2016).
Another lingering policy question is the extent to which countercyclical GSE activity has served as an automatic stabilizer for housing across the business cy-
cle. Fannie and Freddie have been a countercyclical source of funding for mort- gage intermediation, and entirely replacing their mortgage holdings with guar- antees may have significant implications for mortgage and housing markets during credit crunches. The SVAR impulse response analysis in Appendix B provides evidence of an endogenous expansion of secondary mortgage market activity in response to broad-based credit supply shocks, and mortgage lend- ing and housing starts see a similar countercyclical response. A comprehensive analysis of the historical contribution of GSE purchase and securitization activ- ity in stabilizing mortgage flows and housing activity across the business cycle is a related work in progress (Fieldhouse, 2018).
2.8
Concluding Remarks
As a matter of theory, credit policies can expand targeted lending volumes through subsidies and guarantees. In the presence of credit frictions or an in- elastic supply of savings, however, credit policies stimulating a targeted form of lending may inadvertently ration credit away from other uses. While the potential for credit policies to crowd out lending has broad, long-standing the- oretical backing, quantifying such credit reallocations in calibrated models is highly sensitive to assumptions about the supply of credit (Gale, 1991; Lucas, 2016). Exploiting exogenous variation in the mortgage holdings of Fannie and Freddie, I document evidence of U.S. housing credit policies reallocating credit away from commercial lending. My identification strategy can speak to real- financial linkages of housing credit policies, unlike related partial equilibrium models of the effects of federal credit policies. I find that the reallocation of credit ensuing from regulatory shocks to GSE purchases maps to a related real-
location of construction activity across sectors.
Federal policymakers have shown a proclivity for ad hoc uses of credit poli- cies, particularly during periods of financial distress. With their past conduct of housing credit policies via secondary markets, policymakers appear capable of increasing home mortgage lending and stimulating single-family housing in- vestment, as intended, through a subsidy channel. These partial equilibrium effects, however, are effectively offset in general equilibrium by unintended re- allocations arising from an imperfectly elastic supply of bank loans. Housing credit policies appear broadly neutral for total construction spending and em- ployment, casting doubt on the efficacy of their use as stabilization policies, as was common up through the 1980s and again during the Great Recession. Ev- idence of a zero sum nature of U.S. housing credit policies should serve as a cautionary tale to policymakers for their use of credit policy and housing subsi- dies more broadly. If subsidizing an expansion in mortgage borrowing crowds out commercial lending because of a partially inelastic supply of bank loans, the home mortgage interest deduction may induce similar credit crowd out.
While my empirical strategy is well suited to quantifying credit and real reallocations, a drawback is the inability to speak to welfare. Credit policies are often justified in terms of correcting market failures (Elliott, 2011), and in- crease welfare in some adverse selection models of credit rationing (Smith, 1983; Gertler and Kiyotaki, 2010; Lucas, 2016). Yet credit policies are distortionary and, under different assumptions about contracting frictions and the function- ing of capital markets, are found to decrease welfare, particularly when account- ing for fiscal costs (Gale, 1991; Williamson, 1994). Fiscal costs aside, the theory of the second best seems a reasonable framework for thinking about credit poli-
cies. Would market failures under-allocate credit to housing without federal credit policy interventions? Perhaps at times, say when housing credit policies were first launched during the 1930s, or when the Fed launched QE1 in 2008. That seems far less likely during 1990s and early 2000s, when Fannie and Fred- die were allowed to rapidly expand, likely contributing to the housing bubble through a subsidy channel. Subsidizing mortgages may reap political rewards, but is by no means necessary for supporting mortgage liquidity via secondary markets. While reversing the longstanding stance of subsidized housing credit policies might increase welfare, it surely would not be a Pareto improvement: housing credit policies create winners and losers, as would unwinding them.
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